Kcell: Review of 9М2017 results

"Sell" recommendation with 12M TP of 1390KZT per share

Andrey KozhokaruDecember 11, 2017

In contrast to the modest results for 1H2017, Kcell’s shares increased by 31.5% since July 20, reaching KZT 1 700 as of December 6, 2017. We believe that in 2017, the Company passes the lowest point of the period of its financial results deterioration, which began in 2015. Despite expectations of the moderate growth of performance, Kcell’s shares, in our opinion, look overvalued from the perspective of the current business model. Kcell will remain attractive due to its dividend payments, the average annual growth of which we expect at 11% y/y for the period of 2017-2022. Meanwhile, the Company will continue to bear the increased debt burden and significant capital expenditures related to the deployment of 4G network and infrastructure expenditures. We attribute the premium in the Company’s shares to the expected exit of the major shareholder- Telia Company by the end of 2017. Considering current price we change our recommendation from Hold to Sell shares of Kcell with 12M TP of 1 390KZT per share or 4.16USD per GDR.

The absence of a comprehensive package of services as a structural disadvantage. With a customer base of 10 million as of September 30, 2017, Kcell remains the undisputed leader in the Kazakhstan mobile market segment by the number of subscribers and total revenue. Despite the extensive subscriber base, the Company does not have bundle offers of wired Internet and television for individuals, which is a significant disadvantage relative to competitors offering a much wider range of services in one contract. Besides the fact that the lack of bundle offers limits the total potential revenue, Kcell looks less attractive for subscribers who want to receive a full package of services from a single operator.

The further deployment of 4G and the infrastructure development. Due to the further deployment of the 4G network, the Company will be able to significantly increase the volume of traffic sold and, despite the continuing decline in the ARMB, will maintain a high growth rate of revenue from data transmission services. The same also applies to its competitors, Beeline and JV Kazakhtelecom-Tele2. Despite the agreement with Beeline on the division of 4G deployment expenditures and taking into account the relatively fast development of 4G network (45% coverage of the population, according to 3Q2017 results), Kcell will bear considerable capital expenditures in the medium term. In addition, the Company does not have its own network infrastructure in a number of regions, which makes it dependent on the networks of other operators and entails continuing expenses for the leasing of communication channels.

A dependence on the strategy of competitors. One of the reasons for the rapid reduction of Kcell’s subscriber base, observed in 2014-2016, was the large-scale expansion of Tele2 on the Kazakhstani market. The lower tariffs, which form the basis of Tele2 development strategy put considerable pressure on the profitability of the entire industry. Taking into account that the whole Kazakhstani mobile market is divided among 3 companies - Kcell, Beeline and JV Kazakhtelecom-Tele2, Kcell has to maintain sufficient capital investments relative to its opponents in the sphere of the core business, and also to increase the presence in perspective segments to grow its market share.

The target price is 1 390KZT per share, the Sell recommendation. Given the modest optimism in the forecasts for Kcell's financial results, risks associated with the dependence of the Company on the infrastructure of other operators, the need to maintain a high level of capital expenditures for retaining market positions, and a high premium in the share price based on the expectation of the major shareholder change, we recommend to Sell KCEL.KZ with 12M TP of 1 390KZT per share.